2.7.4. Frameworks for Analyzing Relationships

Introduction

There are a number of distinctive frameworks that can be used to analyze and evaluate inter-firm relationships. These frameworks emphasize different characteristics of the relationships, although some characteristics are common across more than one framework. Three types of frameworks are:

  1. cooperation and competition framework
  2. transaction cost framework
  3. political economy framework

Each provides a useful perspective for analyzing the effectiveness of inter-firm relationships.

Cooperation and Competition Framework

This framework describes the extent to which firms cooperate and compete in a way that drives the industry as a whole to be more or less competitive. Both cooperation and competition can be either effective or ineffective. Relationships that are conducted using ineffective cooperation and competition tactics drive limited or decreasing competitiveness. Relationships that are conducted using effective cooperation and competition tactics drive upgrading and increased competitiveness. Tactics of effective and ineffective cooperation and competition look differently within the contexts of vertical and horizontal relationships.

Cooperation/Competition Effective Ineffective
Horizontal
Cooperation Firms cooperate on joint interests and this drives upgrading -- Effective cooperation is a requirement for competitiveness and takes the form of firms that cooperate in ways such as the following:
  • market jointly to meet customer requirements
  • bulk orders to reduce transaction costs
  • share capacity to maximize capacity utilization,
  • learn from peers to increase the pace of upgrading
  • advocate on policy issues
 Firms cooperate on joint interests and this does not drive upgrading -- Ineffective cooperation within a functional level limits or reduces competitiveness and takes the form of firms that:
  • collude to reduce competitive pressure to upgrade
  • collude to achieve unreasonable margins or a concentration of benefits
  • collude to raise barriers to entry
Competition Firms compete on upgrading -- Competition that drives upgrading is a requirement for a competitive industry because it pressures firms to:
  • upgrade their product qualities or processing techniques
  • upgrade their operations
  • upgrade their branding strategies
 Firms compete on factors and tactics that do not result in upgrading -- This limits and often reduces competitiveness as it pressure firms to:
  • use price-only tactics (without productivity gains)
  • use political tactics (information hoarding, misinformation, political connections, and political position)
Vertical
Cooperation Firms cooperate on joint interests and this drives upgrading -- Cooperation between functional levels is effective when firms:
  • use additive negotiation tactics (i.e., incentives to perform, a clear end-goal of repeat transactions and a longer-term interdependent perspective)
  • embed service delivery
  • engage in joint marketing (i.e., competing against other channels or value chains)
  • advocate on policy issues
 Firms cooperate on joint interests and this does not drive upgrading -- Typically firms looking for monopolistic gains cooperate at a functional level, but multi-functional groups or whole channels can collude to:
  • reduce competitive pressure to upgrade
  • gain unreasonable margins or concentrate benefits
  • raise barriers to entry
Competition Firms compete on upgrading -- Direct effective competition between functional levels is rare as the firms perform different operations, but any competitive pressure should:
  • upgrade their product qualities or processing techniques
  • upgrade their operations
  • upgrade their branding strategies
 Firms compete on factors and tactics that do not result in upgrading -- This is particularly damaging to competitiveness of a value chain when firms:
  • use price-only tactics (without productivity gains)
  • apply zero-sum negotiation tactics (a clear end goal of a win-lose outcome)
  • use political tactics (information hoarding, misinformation, political connections, and political position)

Transaction Cost Framework

Transaction costs are the costs of conducting commercial relationships. They include the costs of gathering information, negotiating contracts and enforcing the terms of contracts. According to the theory behind this framework, transaction costs exist because firms do not have access to perfect information (i.e., they have bounded rationality) and because some firms seek to exploit situations in unscrupulous ways (i.e., they behave opportunistically). The concepts of bounded rationality and opportunism are useful in understanding the factors that influence trust in inter-firm relationships. Trust is more difficult when some firms have information that others do not (i.e., there are information asymmetries).

Another concept from the transaction cost framework, asset specificity, is helpful in understanding the willingness of firms to invest in one another. For example, a buyer might invest in its suppliers by providing training and technical advice. The suppliers, in turn, invest in the buyer by adopting the technical recommendation and producing a product that is tailored to the unique needs of the buyer. These types of investments in inter-firm relationships can be found in value chains for agricultural, manufactured and handmade goods. The investments create specific assets in the buyer and suppliers that make them more valuable to each other.

Investments in inter-firm relationships will only occur when there is a reasonable expectation of some kind of return. The buyer invests time in building suppliers’ capacity based on the expectation that product characteristics will improve; suppliers improve their products based on the expectation that the buyer will purchase the upgraded product at a premium price. Short-term investments, such as the provision of quality inputs on credit, can be recovered in a single product cycle. Confidence that longer term investments, such as assistance with certification or capital equipment, is based on some degree of trust that the inter-firm relationship will continue into the future.

Political Economy Framework

The political economy framework is useful for looking at power and governance in a value chain. Power in inter-firm relationships is the ability to influence or determine the terms of a transaction, such as price, quality standards and/or delivery dates. When power is relatively balanced, both (all) firms have a significant influence on the terms of the transaction. That is, both (all) firms bring considerable bargaining power to the table. Power is unbalanced when one group of firms consistently are able to exercise greater power in the relationship than some other group of firms.

In inter-firm relationships, unbalanced power is much more common than balanced power. When some firms consistently hold stronger bargaining positions than other firms, the issue then becomes how the power is wielded. The use of power in inter-firm relationships is considered effective if it leads to greater competitiveness for the value chain, increasing number of MSEs contributing to and benefiting from the value chain’s competitiveness, and continuous upgrading at the firm and chain levels.

When power is used in ineffective ways, the focus should be on identifying the incentives that drive the problematic wielding of power and then fostering changes to those incentives. The incentive may be as simple as a traditional adversarial attitude that has long outlived its usefulness. Or, more commonly, it may stem from basic profit-maximizing behavior in which any advantages, including monopolistic market position or information asymmetries, are exploited for greatest benefit to the more powerful firm.

The best way to change this behavior is to demonstrate how the powerful firm can improve profits and make them more sustainable by changing the way it wields power. For example, in order to maximize short-term profits, Indian supermarket[1] chains reneged on forward contracts with smallholder producers whenever market prices fell. The smallholders responded by engaging in side-selling and failing to produce to the required specifications. This drove down the profits of both the supermarkets and the farmers. By encouraging supermarkets to invest in long-term relationships with their smallholder suppliers, one project helped certain retail chains to distinguish themselves from the competition by having a consistent supply of quality fresh produce.

Using the Frameworks in Practice

There are many ways to look at inter-firm relationships, including the three models described above. These can be applied to better understand both the static and dynamic aspects of inter-firm relationships in a variety of situations during project design and implementation:

  • To assess the status of inter-firm relationships in a value chain, as part of an initial value chain analysis
  • To determine the direction and speed with which relationships are changing or have changed, as part of project monitoring and evaluation
  • To identify weaknesses and critical bottlenecks in inter-firm relationships that must be improved for a competitiveness strategy or project intervention to become effective
  • To discover opportunities for small, riskable steps that would provide immediate positive impacts and increase firms’ interest and willingness to undertake more fundamental changes

Each framework suggests a line of questions that can be used to analyze relationships, diagnose problems and uncover possible solutions. Effective relationships exhibit cooperation and competition that drives upgrading; extensive information flows and learning; the ability to restrain opportunism and engender trust; and the utilization of power to catalyze change resulting in competitiveness for the value chain and greater benefits for the firms operating in it.

Footnotes

  1. ↑ Growth-Oriented Microenterprise Development Program (GMED), ACDI/VOCA, USAID/India